With the 3.1% decline in the DJIA and 44% spike in the VIX yesterday, we wanted to dust off our bullhorn and re-emphasize why real-time risk analytics are critical in successfully managing trading risk in a volatile market. Here are three reasons why it’s so important:
(1) Real-Time Risk Analytics Bridge the Gap Created By Bad Data and Poor Liquidity. First let’s go back to basics. In this type of fast moving market environment, real-time risk analytics are essential. For example, options market participants need the highest quality implied volatilities, Greeks and scenario analysis to have full visibility into their current portfolio risk at any moment. That’s true whether it’s for initiating a trade or hedging positions. In market conditions where liquidity is spotty, it is essential to have accurate, real-time, adaptive theoretical prices and risk metrics to fill the data gaps and separate the bad data from the good.
(2) Real-Time Margin Calculations Prevent an End of Day Surprise. Margin is a real cash flow that needs to be monitored and managed throughout the day. Calculating intraday margin using real-time position information but prior-day clearinghouse risk files – as is often done in practice – is prone to substantial error, especially in volatile markets and with non-linear instruments such as options. Calculating clearinghouse risk vectors in real-time using clearinghouse methodologies (e.g., OCC TIMS, OCC STANS, and SPAN) and applying these to a specific portfolio is the only way to truly capture current market conditions and ensure preparedness for end-of-day margin requirements.
In the market dislocation of February 5, 2018, some proprietary trading firms and hedge funds had end of day P&L and margin calculations that differed substantially from their clearing firms’ calculations. Market participants must be able to accurately model margin risk throughout the day to ensure alignment with their clearing firms and prevent unpleasant end-of-day surprises.
(3) Real-Time Scenario Analysis Prepares for the Future Unknown. What if the market goes up or down by 10%? Or volatility spikes? Or skew flattens? Real-time scenario analysis can measure how changes in market conditions will affect individual securities or an entire portfolio by shocking variables such as price, time and volatility. Hanweck’s real-time scenario analytics tools allow users to modify scenarios on the fly – and can deliver thousands of customized scenarios for each security in real time to better prepare and understand the impact of potential market moves on a portfolio.
These are all critical building blocks of an effective trading and risk management strategy in volatile markets. The cost-benefit is clear on days like yesterday. But what about at other times when the markets are humming along and the VIX is steady (and low)? Some firms hesitate to commit the resources required to perform these big data analytics in real time: quantitative developers, compute infrastructure and reference data management. An “analytics-as-a-service” solution (ahem, like Hanweck’s) solves this problem by substantially decreasing the resource commitment required while managing all of the challenges of calculating clean input data - price smoothing, volatility smoothing, reference data adjustments, etc. Now is the time to prepare. Now is the time for real-time risk analytics.